Sunken valuations make hot buys in apparel

ColleenBazdarich

SAN FRANCISCO (CBSMW) -- After a holiday season in which consumer spending approached all-time highs, apparel retailers have still not been able to successfully jumpstart their stocks out of a slump.

"For companies that are going to grow at 25 to 30 percent a year, the valuations are extremely attractive."

Marcia Aaron, Deutsche Banc Alex Brown

Call it a case of the "techies," a virus that seems to have hit all sectors outside of technology. Along with investors pretty much saying "who cares" about most of the retailers, stocks have also been hit by more worries about interest rates and fears of an impending end to the economic boom, says Marcia Aaron, analyst at Deutsche Banc Alex Brown.

So far, Gap has been the stronghold -- its stock has been rising while other retailers remain in the doldrums -- but Aaron believes the biggest growth opportunities remain to be had in Abercrombie & Fitch, American Eagle Outfitters and Pacific Sunwear, whose designs are cashing in on young America's love for the "outdoors-meets-the-street" look.

CBSMW:So the retailers supposedly had a great holiday season this past December, and yet stocks in Abercrombie & Fitch
ANF, -0.84%
and Intimate Brands
IBI, +17.02%
have been down. What has been going on there?

Aaron: I think that there has been a real dichotomy between the fundamental performance of the companies and the stock performance. There are three reasons.

One is concern about the rate environment, because retail stocks historically have had some dependence on rates. Two is concern that the economy is topping out and that it doesn't get much better from here. Then three -- I think this is affecting lots of different areas of the market -- it has just been a lot easier to make money in the technology arena and and so nobody cares about anything but tech.

CBSMW:So it doesn't really have much to do with the companies themselves?

Aaron: No. You know, Abercrombie has had some issues which are pretty well documented relating some questions about sales that surfaced in October -- they are subject to an FTC investigation regarding subjective disclosure. I think that is part of the reason that their stock is down more than some others, but a lot of other retailers have had just as much compression in their multiples as Abercrombie has.

CBSMW:What are you expecting from Abercrombie's report Tuesday?

Aaron: We are looking for earnings of 73 cents and same-store sales of 6 percent and we feel pretty confident that they will be able to upside our earnings estimate.

CBSMW:What about some perspective on what's going to be going on in 2000?

Aaron: This year I think one of the trends we will see this year in the whole apparel sector in general is some slowing of same-store growth due to difficult comparisons. In 1999, we estimate Abercrombie had 12 percent comps (comparable store sales growth) and that was on top of 35 percent in 1998. As we look at 2000 we think they will do mid-single-digit comps with potential for a little upside but not a lot.

CBSMW:Gap stock has actually been up. What do they have that the others don't?

Aaron: I think in an environment where people aren't embracing a group broadly, you see investors really concentrate their holdings into one name and, Gap being the biggest and the best in the industry, I think that is really what people are doing. They're saying "Hey we don't want to be broadly exposed to retail but if we are going to have some exposure, in apparel it's Gap."

CBSMW:Are you looking for a good report from Gap next week?

Aaron: We are expecting they will be in line to slightly better. I think there is more upside with an Abercrombie or an American Eagle.

CBSMW: What about American Eagle Outfitters? They seem to have the same sort of spin as Abercrombie.

Aaron: American Eagle
AEOS
has done extremely well. They had among the best same-store sales in all of 1999 with comps up 21 percent, and it looks like their profits will be up 59 percent for the year. We are looking for a 35 percent increase in the fourth quarter to 70 cents.

CBSMW:You were talking before about the three reasons why the stocks have been down. Do you think that investors are warranted in these selloffs? Or is the outlook for 2000 actually going to be brighter than investors are expecting?

Aaron: I think in certain names, the outlook continues to be quite bright in 2000. You have companies like an Abercrombie and an American Eagle only trading at P/E multiples in the teens (based on) trailing 12-month earnings. To me, for companies that are going to grow at 25 to 30 percent a year, the valuations are extremely attractive.

CBSMW:Do you see a turnaround for the stocks up ahead?

Aaron: We have been hoping that the seasonally strong February would help them out, but so far it hasn't done a lot for the group. Hopefully the release of earnings will answer some of the questions in investors' minds and relieve some fears and hopefully release the stock so that they can move forward.

Aaron: We think that they have done a really good job executing through some fashion changes in young men's fashion -- mainly the switch from wide legs to narrower legs.

CBSMW:Yes -- that's funny. Whenever I talk to an analyst about apparel, it's always about the wide leg to cargo pants transition.

Aaron: A lot of other retailers took a lot longer than PSun did to execute through that. We also think they are making good progress in the juniors arena -- young women's clothing. They still have tremendous growth opportunity in both the Pacific Sun as well as the Demo concept which goes after more of a hip-hop culture.

CBSMW:Do you have a 'buy' on Gap?

Aaron: We have a "buy" on Gap. The first few that I mentioned were our "strong buy" ratings. Our favorites among the "buy" group are Gap and Limited
LTD, -9.77%

CBSMW:There is the Limited for women and there is a spin-off -- Too?

Aaron: Right. that would be Too, Inc
TOO, +2.08%
We think they are going to have a great quarter as well.

CBSMW:What would you advise for investors getting into these stocks long term at this point in time?

Aaron: I think long term the key issue is to buy the best and the brightest. You really want to buy those companies that are branded and protecting their brand and taking the brand into multiple channels. The Gap is taking their brand into both storefront and other direct selling like the Internet.

CBSMW:Do Abercrombie and American Eagle and the Gap go after pretty much the same demographic?

Aaron: Gap is going to be much broader because they have such an emphasis on basics that they really attract a wide range of consumers. To me their concept is all encompassing. Obviously with their Banana Republic and Old Navy stores, you get everything from play wear to more dressy attire. Your age group is really zero to 50 or 60.

American Eagle and Abercrombie are a little more narrow. The difference between those two is that Abercrombie really tries to go after the opinion leaders and the consumer that is really brand conscious and image conscious, whereas American Eagle outfitters really is trying to go after a mass consumer. Their price points are lower -- they are really trying to attract a broad customer base. Abercrombie is a little bit more of the college crowd, a little bit older.

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